The Red Menace

So two misunderstandings. One is that you have to balance the budget to reduce the debt load. Yglesias tackles that here.

With great fear of being taken out of context by Ron Paul supporters I should make clear that the debt only has to grow more slowly than the Nominal GDP, not Real GDP for the debt burden to fall.

So if our total debt is $10 Trillion and our economy is growing at 5% nominally, then any deficit less that $500 Billion will tend to shrink the debt burden. Any deficit greater than $500 Billion will tend to increase it. This is why we haven’t had many surpluses in US history but the the debt burden is usually falling.

The reason its nominal GDP that counts is because interest payments are figured in as part of the deficit. Suppose we have lots of inflation. That will tend to make interest payments on the debt rise. You could think of this as the debt growing to match inflation.

However, the US Budget accounts for interest payments on the debt. So when you are comparing the deficit to the growth rate of the economy, you have already accounted for the debt growth due to inflation.

The second thing you can see from that graph is that the debt burden has been much higher in the past.

In 2009 we just broke through the Reagan-Bush peak and haven’t come close to the WWII peak. Moreover, this is dominated by the recession. The recession contributes in four ways

A smaller economy means less revenue and hence a higher deficit. This amplified by our progressive tax structure

A smaller economy means lower GDP, and so the debt burden is divided by a smaller number

Tax cuts, spurred on by recession have brought down revenue still further

Spending, automatic and planned has increased in response to the recession

As the economy improves the northward spike will abate.

In the out years we can talk about deficits that are set to accumulate. However, this represents health care costs that the government has promised to pay for but not promised to tax for. In theory either of those promises could be changed.

More importantly, however, health care takes resources away from the rest of the economy whether the government pays for it or not. Obsessing over future budget deficits because of Medicare and Medicaid but ignoring future stagnant or even falling take home pay because of private health care is silly.

We could just end any and all public financing for health care tomorrow and the budget deficit and future deficits would vanish. Woo-hoo! However, the problem of expensive health care would still be with us.

3 comments

Health care is expensive precisely because so much public money is directed at it. If private individuals were as wasteful with their own money, we might get the same result. But the RAND health experiment shows people will cut back on wasteful health services if they have to pay for it.

I generally agree. The actual stable growth rate is going to also be a function of the term structue of debt. If all the debt is in 30 year long bonds, the year over year change in interest will be stable on nominal terms. Changes in rates due to inflation won’t matter as much (only in the new debt that was created in the past year). Conversely, if all the debt is on the short end of the curve, your interest payments in the budget will be much more sensitive to inflation.

So by your reasoning, does that make the nominal growth rate the lower bound? Policy wise, should we advocate more borrowing on the long end of the curve for the government?